Friday, May 31, 2013
Bogle Talks Tough Truths
Reported by Tommy Fernandez
Don't mess with Mr. Bogle.
The impassioned, tough-talking Father of the Index Fund, and founder of Vanguard
, said it like it is during a speech before the Boston Security Analysts Society
on May 17th.
In the speech, titled Big Money in Boston
, Bogle made some of his always-bold declarations about the industry.
Here are just a few:
The Rise of “Product Proliferation”
When I entered the industry in 1951, there were but 125 mutual funds, dominated by a few leaders.
Today, the total number of equity funds comes to a staggering 5,091. Add to that another
2,262 bond funds and 595 money market funds, and there now are 7,948 traditional mutual
funds, plus another 1,446 exchange-traded index funds (which are generally mutual funds
themselves). It remains to be seen whether this quantum increase in investment options—ranging
from the simple and prudent to the complex and absurd—will serve the interest of fund investors.
I have my doubts, and so far the facts seem to back me up.
Failure Rate of Funds
With the rise of all of that product proliferation, the fund industry has come to suffer a
rate of fund failures without precedent. Back in the 1960s, about 1 percent of funds disappeared
each year, about 10 percent over the decade. By 2001-2012, however, the failure rate of funds
had soared seven-fold, to 7 percent per year, during that entire period, 90 percent. With about
6,500 mutual funds, 5,500 have been liquidated or merged in other funds, almost always into
members of the same fund family (with more imposing past records!). Assuming (as I do) that
such a failure rate will persist over the coming decade, some 3,500 of today’s 5,000 equity funds
will no longer exist—the death of more than one fund on every business day. While the mutual
fund industry proudly posits that its mutual funds are designed for long-term investors, how can
one invest for the long term in funds that may exist only for the short term?
Another implication of proliferation is the extraordinary (and, again, truly absurd) rise in
expense ratios. Just consider eight of the major fund managers of 1951 that survive today.
Exhibit 9. Despite the quantum growth in the assets they manage, the expense ratios of their
funds have soared—from an average of 0.62 percent of assets to 1.15 percent, or by 84 percent.
(Note that four of the largest fee increases came in firms that were publicly-owned.) By contrast,
the only mutually-owned firm (of course, Vanguard) actually drove expenses down from 0.55
percent to 0.17 percent, a drop in unit costs of fully 69 percent. Look. When the expense ratios of 13
funds that operate under the original industry model rise by 84 percent, and the expense rati
Despite the far-reaching consequences of its unfortunate birth, “conglomeratization” has
been the least recognized of all of the changes that have beset the mutual fund industry. Financial
conglomerates now own about two-thirds of the major fund management companies, and with
the publicly-traded firms, more than 80 percent. However, for whatever one wants to make of it,
each of today’s three largest fund complexes—Vanguard, Fidelity, and American Funds—has
remained independent. These three firms alone manage $4 trillion, or some 30 percent of all
mutual fund assets.
What’s the problem? It’s summarized in Matthew 6:24: “No man can serve two masters.”
Yet when a management firms is owned by a giant conglomerate (or even by public owners), the
conflict of interest is palpable. When a conglomerate buys (or builds internally) a fund
management company, the acquirer’s goal is to earn the highest possible return on that capital.
That’s American way! The idea: maximize fees by gathering assets and creating new products,
and resist reductions in fee rates that would enable fund shareholders to benefit from the
economies of scale.
But fund shareholders, of course, would benefit from lower fee rates, which would
increase their returns, dollar for dollar. Think of it this way: the officers and directors of financial
conglomerates have a fiduciary duty to increase the returns earned by their corporate
shareholders; they also have a fiduciary duty to increase returns to their mutual fund
shareholders. As Matthew suggested, this obvious conflict in serving two masters will cause
them “to love the one and hate the other,” and I think that this audience knows which master gets
the love. There can be only one resolution to the conflict: a federal policy that prohibits the
ownership of fund managers by holding companies.
“Trafficking” in management contracts, and the
likelihood that it would dramatically erode the sense of fiduciary duty that largely characterized
the industry during its early era. And product proliferation hardly helped. So I reiterate: How can
an independent fund director feel a fiduciary duty to the hundreds of fund boards on which he or
Read the full text of the speech here
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